What is yield maintenance?

Yield maintenance is a prepayment penalty that is often associated with commercial real estate loans. It is a method used by lenders to ensure that they receive a certain amount of interest income when a borrower decides to pay off their loan early.

When a borrower wants to prepay their loan, the lender calculates the present value of the remaining cash flows on the loan based on the original interest rate and the current market interest rates. If the present value is less than the remaining loan balance, the borrower must pay the difference, known as the yield maintenance fee, to the lender.

Yield maintenance is considered a more expensive prepayment penalty compared to other methods such as defeasance or prepayment penalties based on a fixed percentage of the loan amount. However, some borrowers prefer yield maintenance because it allows them to pay off their loan early without incurring additional interest costs.

Overall, yield maintenance is a complex and often misunderstood concept in the world of commercial real estate financing. Borrowers should carefully consider the terms of their loan agreement and consult with a financial advisor to determine the best prepayment option for their specific situation.